Dell Computers wants to borrow pounds, and Virgin Airlines wants to borrow dollars. Because Dell is better known in the United States, it can borrow on its own dollars at 7% and pounds at 9%, whereas Virgin can on its own borrow dollars at 8% and pounds at 8.5%.
a. Suppose Dell wants to borrow £10 million for two years, Virgin wants to borrow $16 million for two years, and the current ($/£) exchange rate is $1.60. What swap transaction would accomplish this objective? Assume the counterparties would exchange principal and interest payments with no rate adjustments.
b. What savings are realized by Dell and Virgin?
c. Suppose, in fact, that Dell can borrow dollars at 7% and pounds at 9%, whereas Virgin can borrow dollars at 8.75% and pounds at 9.5%. What range of interest rates would make this swap attractive to both parties?
d. Based on the scenario in part c, suppose Dell borrows dollars at 7% and Virgin borrows pounds at 9.5%. If the parties swap their currency proceeds, with Dell paying 8.75% to Virgin for pounds and Virgin paying 7.75% to Dell for dollars, what are the cost savings to each party?